LEASE ACCOUNTING: Classification, Recognition, and Financial Reporting (ASC 842 & IFRS 16)
- Graziano Stefanelli
- Jun 11
- 3 min read
Lease accounting governs how companies report assets and liabilities arising from leasing arrangements.
Modern standards require most leases—previously off-balance-sheet—to be capitalized, reflecting the right to use an asset and the obligation to pay for it.
1. What Is a Lease?
A lease is a contract that conveys the right to use a specific asset for a period of time in exchange for consideration.
Applies to:
Equipment and vehicles
Office or retail space
Warehouses and land
IT hardware or telecom infrastructure
Under ASC 842 (US GAAP) and IFRS 16, almost all leases are now recorded on the balance sheet by lessees.
2. Lease Types: Finance vs Operating
Under ASC 842 (US GAAP):
Lease Type | Criteria (any one → finance lease) |
Finance | - Transfers ownership at end |
- Includes purchase option likely to be exercised
- Term is major part of economic life
- PV of payments ≈ fair value
- Specialized asset (no alternative use) |
Under IFRS 16:
All lessee leases are treated like finance leases (no operating lease classification), except for:
Short-term leases (≤12 months)
Low-value assets (e.g. laptops, printers)
3. Initial Recognition and Measurement
Lessee records:
A Right-of-Use (ROU) Asset: The economic benefit of using the leased asset
A Lease Liability: The present value of future lease payments
Initial journal entry (lessee):
debit Right-of-Use Asset
credit Lease Liability
Example:
PV of lease payments: €40,000Initial direct costs: €2,000
debit ROU Asset ................................................ 42,000
credit Lease Liability .......................................... 40,000
credit Cash (direct costs) .................................. 2,000
4. Subsequent Accounting — Lessee
Component | Finance Lease (ASC 842 & IFRS) | Operating Lease (ASC 842 only) |
ROU Asset | Depreciated over lease term | Same |
Lease Liability | Reduced by lease payments | Same |
Expense Pattern | Interest + Depreciation (front-loaded) | Single lease expense (straight-line) |
Journal entries over time:
Depreciation (ROU asset):
debit Depreciation Expense
credit Accumulated Depreciation – ROU Asset
Interest on lease liability:
debit Interest Expense
credit Lease Liability
Lease payment:
debit Lease Liability
credit Cash
5. Lessor Accounting
Lessors classify leases as:
Operating leases (retain asset, recognize income over term)
Sales-type / Direct financing leases (transfer asset and derecognize)
Lessors do not record ROU assets. Instead, they continue recognizing the underlying leased asset unless it’s a sales-type arrangement.
6. Short-Term and Low-Value Leases
IFRS 16 allows lessees to opt out of capitalization for:
Leases ≤12 months
Assets of low individual value (typically <$5,000)
Such leases are expensed straight-line over the lease term.
Example journal entry:
debit Lease Expense
credit Cash
7. Financial Statement Presentation
Lessee:
Balance Sheet:
ROU Asset under “non-current assets”
Lease Liability split between current and non-current
Income Statement:
Depreciation and interest (finance lease)
Lease expense (operating lease under GAAP)
Cash Flow Statement:
Principal → Financing activity
Interest → Operating (GAAP default) or Financing (IFRS option)
8. Disclosures
Lessee disclosures must include:
Maturity analysis of lease liabilities
Depreciation and interest expense
Weighted average remaining lease term
Discount rate used
Expense breakdown for short-term or variable leases
Significant assumptions and judgments (e.g. renewal likelihood)
Key take-aways
Most leases must now be capitalized on the lessee’s balance sheet.
The ROU asset and lease liability represent the economic rights and obligations under the contract.
Classification affects expense recognition and financial ratios.
Proper lease tracking and system support are critical for compliance and reporting.
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